Taking out a personal loan is exactly that — personal. But does your lender need to know how you plan to use funds?
In short, yes. While most reasons won’t stop you from obtaining a personal loan, you’ll need to explain why you need the money you’re borrowing. You can generally use the loan proceeds however you see fit, but some lenders have restrictions. Plus, the loan purpose could impact the loan terms you receive.
Why does the purpose of a loan matter?
The purpose of a loan matters for a variety of reasons. First and foremost, some lenders have limitations on how the money can be used. While debt consolidation, making large purchases or covering the costs related to vacation are all acceptable uses for personal loans, some lenders may not allow the money to be used for tuition or continuing education expenses or to repay another student loan.
Lenders may also prohibit using a personal loan for investing or to make the downpayment on a home. In short, the purpose you’re seeking a loan matters because the lender needs to determine whether the money will be used for a purpose they allow.
In addition, the loan purpose may also influence the interest rate you’re offered. While many lenders make interest rate determinations based on factors like your credit score, loan amount and loan term, some also consider what the money will be used for when developing the rate offer for a loan. Lenders may charge a higher rate if you plan to use the loan for debt consolidation versus making a significant purchase with the money.
Common reasons for taking out a personal loan
Your loan purpose is the reason you want to borrow money. When you fill out a loan application, you might come across a section that asks why you are applying. Some lenders do this to match you with the right product. They can also use your loan purpose to assess risk and assign loan terms.
There are many reasons you may want to consider taking out a personal loan, including:
- Child-related costs: If you want to expand your family, a personal loan can cover the costs of fertility treatments, adoption expenses or hospital bills from labor and delivery. While it can also help cover needs after your child comes home, a personal loan is usually best for fixed costs.
- College expenses: If you or your child are enrolled in college and have outstanding tuition or other related expenses, a personal loan may help fill the void. Sometimes, the interest rates on personal loans are lower than what you’ll find with student loans.
- Debt consolidation: You can save money on interest payments by consolidating high-interest credit card debt with a personal loan with lower interest rates. The average credit card interest rate right now is around 17 percent — versus personal loan interest rates, which average a little over 10 percent. If you have stellar credit, you could secure the lowest interest rate available, which is often much less than a credit card.
- Delinquent debt: Whether you owe a debt collector or the IRS, you can use a personal loan to pay off the outstanding balance and eliminate the added stress.
- Emergencies: If you need to pay bills right now and don’t want to be late, you can take out an emergency loan to cover those costs. If you lose your job, get your work hours reduced or have an emergency medical bill, a personal loan can meet your needs in the short term.
- Funeral and end-of-life needs: A personal loan can pay for the funeral, burial and related end-of-life costs when a loved one dies.
- Home improvements or repairs: If a water pipe bursts or your air conditioning goes out, a home improvement loan can pay for repairs if you don’t have the cash and don’t want to use your credit card.
- Large purchases: You can use a personal loan to buy a recreational vehicle such as a boat, an RV or a private jet — or to improve your quality of life. You can also use a personal loan to spread out the costs of purchases that would take a significant chunk out of your budget, such as dental bills, new appliances and veterinary expenses.
- Major life milestones: If you’re planning a big move for a new job or helping a grown child pay for a wedding, you may need extra cash.
- Vehicle financing: Personal loans can also be used instead of an auto loan to purchase a new or used car, truck or van if you’d prefer not to use the vehicle as collateral.
- Vacation expenses: A regular vacation probably doesn’t warrant using a personal loan to cover the costs. But a personal loan could be worthwhile if you’re looking to cover costs for a vacation celebrating a major milestone, including a honeymoon or anniversary.
Does the reason for taking out a personal loan matter?
Your reason for getting a personal loan can impact the type of loan you take out, as well as the loan amount and interest rate you get.
Some lenders have a specific type of borrower they will lend to. For instance, Happy Money is a lender that serves only borrowers with credit card debt. If you’re looking for a debt consolidation personal loan, that might be a lender to consider. But if you’re looking for a home improvement loan, you’ll need to look elsewhere. Furthermore, some lenders offer different terms for certain purposes.
Lightstream is an example of a lender that sets interest rates based on your loan purpose. For instance, as of June 2023, its general APRs range from 8.89 percent to 24.29 percent with AutoPay. However, depending on your loan use — such as a kitchen remodel or wedding loan — you may see a higher minimum APR.
To make sure you’re getting the best deal, compare interest rates, terms and fees from lenders that are offering personal loans that match your needs. Review credit requirements, such as your credit score, history and income qualifications.
Restricted personal loan uses
Most lenders allow you to use the loan proceeds however you see fit. But if the lender does impose usage restrictions, they likely fall into one of these categories:
- Down payment on a home purchased with an FHA or conventional mortgage: Lenders view this practice as risky as the likelihood of falling behind on loan payments is higher with two loan payments to manage. Although it could take some time, saving up over time in a high-yield savings account is a better alternative to come up with a down payment for a new home.
- Educational purposes, including college tuition and fees: This results from the 2008 Higher Education Opportunity Act, which provides a series of requirements that lenders offering education loans must abide by. Many lenders fail to meet these mandates, so personal loans are often disallowed for higher education expenses. However, federal student loans could be a viable option as they come with low interest rates, and generous loan terms and are available to most students regardless of credit history.
- Business-related expenses and gambling activities: Not all lenders restrict using loan proceeds for these purposes. Still, it’s worth asking as it’s not uncommon to find that business expenses or expenses incurred as a result of gambling activities are prohibited.
What not to use personal loans for
Personal loans can be a fast, convenient way to get needed cash. However, there are instances where they aren’t the best choice. For example, you could get a far lower interest rate and better loan terms if you need funding for a car or higher education and you take out an auto loan or student loan instead. This is also the case for home purchases — a mortgage will get you an extended loan term and competitive interest rate to make your monthly payments more affordable.
Furthermore, you have to evaluate if you need the funds. If you’re looking to cover the cost of something you want versus an actual need, you may be better off saving up over time to make the purchase. Plus, you’ll keep more of your hard-earned money in your pocket by not having to pay interest.
You should also avoid personal loans if you have less than perfect credit. The most competitive loan terms are generally reserved for borrowers with good or excellent credit. A lower credit score doesn’t mean you’ll be denied a loan, but your borrowing costs will likely be higher.
Most importantly, run the numbers to make sure a personal loan makes sense. If the monthly payment stretches your budget too thin, it’s not worth the headache, regardless of how you intend to use the funds.
The bottom line
Your reason for getting a personal loan is yours, but your potential lender can determine important loan factors based on that reasoning. Regardless of why you need a personal loan, compare lenders to see which offers the best deal based on your needs. Avoid borrowing more money than you need, and find a lender with a sensible repayment plan.
Frequently asked questions
The best reason is exactly what you plan on using the loan for. Being honest is the only surefire way to ensure you get your funds in a timely fashion and don’t end up running into trouble down the line.
For most lenders, you can use your personal loan for just about anything. Some lenders base your personal loan rate on your loan purpose. Some lenders have restrictions on how you can use your loan. For instance, some might not allow you to use funds to pay for higher education or business.
Sometimes things change from when you apply for a personal loan to when you plan to use the funds. Say you took out the money to pay for a child’s wedding, but the wedding got postponed or canceled. You could use the funds for other needs, like paying down debt or funding other ventures, like a vacation. But before you use the funds, make sure there are no restrictions from your lender on how you can use those funds. If you’re worried about mishandling the funds, contact your lender to see if your new loan purpose is covered.
